You’ve heard all about the advantages of M&A for businesses, so of course, you’re interested in learning more about it. But what exactly is the difference between the “M” (merger) and “A” (acquisition) in an M&A deal?
There are some big distinctions between a merger and an acquisition. Learning about those can help you make the best decisions for your business.
What is a Business Acquisition?
An acquisition is when one company, the acquiring company, buys another company, which is known as the target company. If the target company is private, then both companies agree on a selling price to buy out the owners’ stakes in the target company.
If the target company is public, then the acquisition involves a decision from the target company’s board of directors before the acquiring company agrees to purchase at least 50% of the target company’s shares. Depending on the size and type of companies involved in the acquisition, the Federal Trade Commission may need to decide that the acquisition won’t result in a monopoly — a situation that could stifle healthy competition and hurt consumers.
At the end of an acquisition, the acquiring company typically takes over senior leadership positions of the target company. The target company may be completely absorbed, or it might operate the same as before the acquisition. However, control over these decisions always rests with the acquiring company.
What Types of Acquisitions Are There?
For small businesses, there are three common types of acquisitions:
- Horizontal acquisition
- Vertical acquisition
- Market extension acquisition
Let’s explore each acquisition type in detail.
When most people think of acquisitions, they think of one company “buying out the competition,” which is better known as a horizontal acquisition.
In a horizontal acquisition, both the acquiring and target companies offer similar products or services to the same market. One purpose for this kind of acquisition is to eliminate local threats to your existing business’s market share. Horizontal acquisitions can also help businesses quickly expand without the time and expense of setting up new locations and hiring new staff.
Example: The owner of an auto repair shop is ready to expand her business in the area. One option is to build more repair garages, but she also knows that her biggest competitor is ready to retire. After doing some due diligence, she decides to acquire her competitor’s business, immediately doubling her market share.
A vertical acquisition is when the target company is a direct supplier or customer of the acquiring company. In other words, the acquisition happens “vertically” up or down the supply chain. Vertical acquisitions help customers have cheaper or more reliable access to critical materials or services.
Example: A bakery owner wants to use more local ingredients. He acquires a nearby dairy farm, which gives his business priority access to milk, butter, and eggs. He also gets an additional revenue stream from the excess products that the dairy farm sells to other customers.
Market Extension Acquisition
A market extension acquisition happens when the acquiring company buys a company that sells similar products or services to another market segment. Compared to a horizontal acquisition, a market extension acquisition can help the acquiring company enter new market segments rather than increase market share in the same segment.
Example: A restaurant owner has several high-end dining establishments that cater to romantic couples looking for a quiet evening. To increase overall revenue, the owner decides to acquire a local restaurant that caters to families with small children.
What is a Business Merger?
A merger is when two companies unite into a single, joint company. The new company includes senior leadership, employees, practices, and cultural aspects from each partner company. Essentially, both companies agree to adopt common business practices, develop the same strategy, and set goals together to achieve success.
Ideally, both partner companies in a merger share equal ownership of and influence over the new company. However, it’s common to see mergers between “junior” and “senior” partners, where one company is in a stronger position and can bring more resources to the joint company. If the partner companies have shareholders, they can be compensated by being given shares of the new company.
What Types of Mergers Are There?
Like with acquisitions, companies can decide whether a merger is a horizontal, vertical, or market extension merger. Here’s an example of each type:
- Horizontal merger: Two local furniture companies decide to merge to take advantage of economies of scale and outcompete a third local competitor.
- Vertical merger: A hardware manufacturer and a software company join forces to form a new company that produces components with built-in computer systems (and the software needed to run them)
- Market expansion merger: Two companies sell the same products on opposite coasts. Both want to expand nationally, so they merge to form a single company capable of reducing costs and accessing more capital.
What’s Better, a Merger or Acquisition?
Now that you understand the differences between a merger and an acquisition, you’re probably wondering which one is the better choice for a successful M&A deal. The answer depends on what you want to get out of the deal. Both types of agreements have their own strengths and drawbacks. Throughout the decision-making process, it’s always a good idea to keep your employees informed to avoid gossip and rumors.
What are the Pros and Cons of a Merger?
- Merger agreements put the two companies on more equal footing than an acquisition.
- Workplace leaders from both companies can contribute to the positive growth and direction of the new company
- A successful merger can result in a new company that’s stronger and better positioned than the sum of the two partner companies alone
- Mergers require a lot more time for negotiation and room for compromise since both companies have a say in the future of the new company.
- It can be challenging to find a company that can work as a true 50/50 partner. “Senior” partners will be less flexible about negotiating, while “junior” partners may not bring as much to the table as you were expecting.
- A poorly executed merger can lead to workplace culture clashes, decreased productivity, and leadership disputes that threaten to undo all the benefits of the merger.
What are the Pros and Cons of an Acquisition?
- There’s clarity about who’ll be in charge — the acquiring company will decide on the structure and leadership of the target company.
- Acquisitions are a good way to access valuable industry intellectual property (IP), such as patents and trade secrets from a target company. The acquiring company can then utilize or improve on IP without running into legal issues.
- The acquiring company can immediately grow with control over the target company’s assets, customers, and product lines.
- The sudden increase in responsibilities and staff can overwhelm senior leadership of the acquiring company, and the business could suffer.
- It’s challenging to determine the value of a target company. There’s a risk that the acquiring company will overpay, which will affect the company’s available capital in the future.
- If the acquiring company decides to cut back on the target company’s staff (a common practice), there’s a risk that the company will be getting rid of key talent.
Whether You Go Merger or Acquisition, Go In Prepared
Both mergers and acquisitions can be exciting as well as disruptive to your team. If your business is involved, proper communication is key to keeping your employees happy and productive. At Confie, we put people and culture above everything. To learn more, get in touch with us or give us a call at (714) 252 2500.